Chinese tutoring company TAL Education Group (NYSE: XRS ) got good grades on this quarter's earnings report, but it's still flunking the semester. So what happened to this seemingly high-growth stock?
TAL reported impressive earnings for the first quarter of fiscal 2013 on July 24. Net revenue increased by nearly 50% compared to the same quarter last year, operating income jumped almost 75%, and net income increased by 8.2% year over year.
Despite these metrics, the company is trading at an all-time low, and shares have lost around 50% of their value since its IPO in 2010.
Detention or suspension?
TAL's share price plunged a couple of weeks ago on news that the company had to discuss some "unusual market activity" with the New York Stock Exchange. More details have not yet been released, but this nebulous statement was enough to frighten shareholders and drive the stock down. July 24's strong earnings report has done little to restore investor confidence.
Interestingly, the SEC recently mounted an investigation of TAL's chief competitor, New Oriental Education & Technology Group (NYSE: EDU ) . This rival education company is being accused of cheating on its financial statements, and its stock price has dropped 50% since news of the investigation broke. To make matters worse, New Oriental is also battling a class action lawsuit from angry investors who feel misled by the allegedly fraudulent financial statements.
New Oriental has some explaining to do, while TAL and its shareholders are both anxious to find out if a chat with the NYSE will develop into an investigation. Is this sector too risky to invest in right now?
School's out (of your portfolio) for the summer
We'll have to wait and see what happens at TAL and New Oriental, but I can't deny that there is some upside for these companies. The first is that many Chinese students are clamoring to gain admission to American Ivy League universities and tutoring services are a growing market. The elite sometimes hire private academic coaches for up to nearly $40,000 per student, but, for middle-class families looking to give their children an edge in an increasingly competitive academic environment, TAL and New Oriental offer more affordable K-12 tutoring services.
The companies are also not as heavily regulated as many U.S. education players are. For-profit schools managed by Bridgepoint Education (NYSE: BPI ) and DeVry (NYSE: DV ) need accreditation to increase enrollment, and businesses like these can rapidly lose market value if they do not get accredited. For instance, Bridgepoint shares dropped dramatically this month after one of its universities was denied accreditation, and shareholders are anxiously waiting to see how Bridgepoint responds.
TAL also has plenty of room to grow. The lion's share of its fiscal 2012 revenue came from offices in Beijing and Shanghai, and the company only operates in 15 cities and runs 270 centers today. Compare that to New Oriental's 664 centers in 50 Chinese cities, and it's clear that TAL can expand in the short-term.
I'm watching two things before making a decision about these companies. The first is an economic slowdown in China; if a recession hits and the middle class has less disposable income to splash on tutoring services, this industry could sink fast. The second, of course, is any proof of fraud. If there was hanky-panky with the financial statements at either company, they will both be an "underperform" for me. Let's wait until the end of the school year to see whether these tutoring companies pass or fail.
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